As the chart below shows, after two positive days to open December, the S&P 500 abruptly changed direction and handed investors a greater than 1.5% drop December 3rd and a drop of nearly 3% to open trading on December 4th. Since the start of October in fact, we have seen a ramp up in the number of days where equity markets move greater than 1%.

Source: Bloomberg

In light of recent trading, we though it was a perfect moment to remind investors of history as it can provide valuable context.

Leaving emotions like fear and greed out of decision making is easier said than done. This is especially true as many investors experienced catastrophic losses during the dot-com crash in 2000-2001 and again during the financial crisis in 2008. It took years to recover from those massive drawdowns, but the pain felt by investors during those events can take even longer to dissipate. In fact, the stock market crashes in 2000 and 2008 have left many investors anchored to those experiences, which create behavioral biases that make it difficult to make sound and well-reasoned investment decisions, especially when markets see an uptick in volatility.

Although we don’t foresee an economic recession looming, there are some signs indicating a softening in economic activity. For this reason, a proactive and well-defined risk management process remains vital for capital preservation. A rational and forward-looking game plan can never be overemphasized, particularly as the current business cycle matures and enters later stages. First and foremost, it is important for investors to have a clear picture of their long-term financial objectives and risk tolerance so that they take on the appropriate amount of risk. Moreover, tactical management based on macroeconomic, fundamental, and technical analysis can help reduce errors and potentially generate excess returns as volatility creates opportunity. That said, to help in achieving those goals we must mitigate human biases that can lead us to react to our environments in ways that are detrimental to our longer-term outcomes.

Anchoring bias is a term used in psychology to describe the common human tendency to rely too heavily, or “anchor”, on one piece of information when making decisions. This is something that investors must overcome, especially today. The reason is that many investors still have vivid memories of both the tech crash and the financial crisis, two market meltdowns which were unusual in three ways: 1) they were both deep declines, 2) lasted longer than most declines throughout history, and 3) occurred in relatively close succession. Only between the late 1920’s and 1930’s had markets also exhibited these three characteristics.

Coming out of the financial crisis the pain investors felt was thus magnified. It also caused many to react emotionally and sell out of investments at or near the bottom. If that wasn’t bad enough, those same investors then experienced “double-losses” as in many cases they were paralyzed by fear and unable to put capital back to work as markets entered a post-crash recovery. To exacerbate the issue, investors now find themselves at the tail-end of a year which has seen multiple corrections, and sudden spikes in volatility as prospects for the economy become increasingly uncertain.

To prevent falling into the trap so many investors did during the financial crisis, it is important to not succumb to anchoring bias. As part of that effort it is helpful to put corrections and bear markets into a historical context. What you will find is that over the last 89 years, corrections and bear markets happen frequently. In fact, from 1928 until 2017, there were 51 corrections of at least 10%. That amounts to a 10% correction every couple of years. Do you remember the one we had in mid-2015? What about the one that lasted from November 2015 until February 2016? If you don’t, you probably have good company. Of course, you likely remember the corrections we have seen during 2018 as recency certainly helps keep those in focus. The episodes this year have thus far been blips as the domestic equity markets hum along but still elicit thoughts of big crashes.

The good news is that big drawdowns of 40%+ are relatively rare events. Going back to 1928, we have had only 7 declines for the S&P 500 of 40% or more. Going back to 1939, it has only occurred 3 times.

Source: STA Wealth Management

Corrections also tend to last relatively short periods of time. In fact, only 11 times have corrections or bear markets for the S&P 500 lasted longer than one calendar year. The longest bear market lasted 929 days, during the dot-com crash. In other words, beware anchoring bias as long-lived bear markets have been exceedingly rare.

Source: STA Wealth Management

Even in 2018, we have seen sharp moves lower followed by a steadying process. Of course, risks that bare watching are always just beneath the surface and a quick snap back to more positive and orderly markets is not a given. Thus, as investors, we must remain aware and have a game plan for any number of scenarios that may unfold. While there is still some time to build your plan, the window to do so may be closing.

Weekly Technical Comment

S&P 500 May Have More Downside to Come

The daily bars in the chart below shows the S&P 500 retesting previous lows formed in late October and late November. And it’s trying to hold there. The shape of the pattern over the past two months, however, isn’t very encouraging.

Not only is the SPX trading well below its 200-day average. The two red converging trendlines containing that current sideways pattern have the look of a “triangular” formation. Triangles are usually continuation patterns (meaning that the current downtrend should continue). That interpretation increases the odds of recent lows being broken. If that happens, that would set up a more important test of the lows formed earlier in the year. It would lead to a major test of the viability of the market’s long-term uptrend.

The end of the year presents a unique opportunity to look at your overall personal financial planning situation. With factors like the 2018 tax law changes, life changes or just working towards your goals, now is an especially important time to review things. It is always a good time to see if you are on-track at your stage in life. Taking what we now know about the new tax law and weaving together all of the other areas of your personal finances is one of the key ways we provide value to you as your trusted adviser. Below are some things we’d like to help you think through before the year ends.

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice. A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.

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